Breakthrough methodology for valuing franchise goodwill- what’s all the fuss about?
The chief examiner of my thesis commented- “It makes important contributions/advances in the scholarship of governance structure, risks, returns, and valuation of franchisee-operated businesses – areas of scholarship that have received only scant attention over the last three decades”
Complexities of franchise contracts
Government intervention in the Australian franchising sector means that franchisors and franchisees cannot deal with each other free of restrictions. Consequently, these restrictions to freedom of contract provide a catalyst for franchise businesses to become increasingly differentiated from those that operate independently, thereby creating nonconformity and incongruity in the way they are structured and operated.
Ultimately, the uniqueness of the franchise arrangement and the incompleteness of franchise agreements create a unique bundle of risks that underscores the complexities associated with the valuation of goodwill of franchises at a change of ownership. Despite these complexities, goodwill valuation can become the threshold of many commercial, operational, and legal disputes requiring resolution. An exciting new intellectual property and goodwill valuation methodology has been developed in my Doctoral Thesis by synthesising agency and finance theories.
Unlike independent businesses, franchises operate within a community of co-dependence. Their welfare is continually influenced by the actions of other franchisees in the system and those of the franchisor, thereby ultimately affecting the goodwill of their businesses. Goodwill is generally defined as the component of economic value in a business that is intangible, unidentifiable, and severally unquantifiable. It is a residual value, calculated by the difference between the sum of the values of identifiable assets employed in the business and the value of the business as a whole. Its value can vary according to the type, size, and prospects of the business and the contractual, relational, and regulatory events that trigger its valuation.
In any franchising arrangement, the intentions of both franchisor and franchisee are reflected in an agreement that essentially deals with the rights and obligations of each party during the term of the commercial relationship and beyond. Whilst these rights and obligations substantively reflect the requirements of a hegemonic franchisor, they are also influenced by statutes that deal with stamp duty, intellectual property, income, capital gains, goods and services, industry codes, and competition and consumer. The need to value goodwill arises from contract and statutes.
Goodwill valuation is typically manifested in change of ownership events such as assignments, buy-backs, expiries, transfers, surrenders, closures, and terminations. These events are triggered mainly by a friendly exit or motivated by discord amongst franchisees, due to their diminishing perception of the value received from their franchisors over time.
The issue of risk is a structural pillar in any valuation construct. Unavoidably, the outcome of any valuation cannot be guaranteed. This systemic problem is further compounded by the unique characteristics of a franchise business and its agency problems. My thesis offers a methodology that blends conventional valuation theories with franchising scholarships and agency theory to present a model, the true value model (TVM), for valuing intellectual property (generally) and goodwill (specifically) in franchises.
The main proposition underpinning the TVM is that the valuation of goodwill of a franchisee-operated business necessarily involves the pricing of specific risks not found in businesses operated independently, such as risks associated with the franchise system as a whole.
The valuation methodology
Given that franchisors and franchisees collaborate towards parallax goals with an overarching intention to maximise firm value, finance theories are embraced to inform a synthesised framework for valuing that collaborative effort. In context of my thesis, that effort is measured by the business goodwill generated by the franchisee. Accordingly, the methodology synthesises agency, finance, and franchising theories to establish baseline values for franchise goodwill under, (a) dependent suspended goodwill and (b) dependent extended goodwill. Fundamentally, the only difference between the dependent and the independent case is a multiplier E introduced in both cases. This multiplier is a relative measure of the effectuality (the actual achievement) and efficaciousness (the potential to achieve) of the franchise system at minimising agency costs and maximising value for both franchisor and franchisee. It is used in the TVM to denote present as well as prospective effectiveness and efficiency at optimising agency costs.
The TVM methodology and its theoretical construct will soon be available for public consumption. It is intended that this breakthrough approach would benefit franchisors, franchisees, lenders, professional advisers, government, as well as investors.
Dr Maurice Roussety is a Consulting Strategist for DST Advisory and Lecturer in Small Business, Franchising and Entrepreneurship at Griffith University in Queensland, Australia. He has worked with leading organisations such as Queensland Transport, IAG, Westpac, Australia Post, Coles Myer, Red Rooster, Commonwealth Bank, ACCC, and Optus. Maurice holds a PhD in Intellectual Property and Franchise Goodwill Valuation. He also holds a Master’s degree in Leadership and in Business Administration. He is available for consulting and public speaking engagements and can be contacted further at maurice@dstadvisory.com or you can visit him at www.mauriceroussety.com.au
